Sandeep Parekh

On May 12, 2023, the Securities and Exchange Board of India (Sebi) issued a consultation paper proposing a regulatory framework to govern fractional ownership platforms (FOPs). These FOPs offer investors an avenue to hold fractional ownership in commercial real estate and earn yield through the rent received and/or appreciation in the value of such property. By governing these platforms, Sebi would be taking a step in regulating fintech offerings after introducing regulatory frameworks for execution-only platforms and online bond platforms last year. Given the global economic scenario, investors have been seeking alternatives to the equity markets. By regulating products such as retail debt offerings and now fractional ownership of commercial real estate, Sebi will be providing viable investment avenues to retail investors.

Presently, the modus operandi adopted by these FOPs is to garner interest from potential investors for investment in pre-identified commercial properties, and set up companies in the form of special purpose vehicles (SPV) that own such properties. Investors become shareholders of these SPVs and gain returns from the rents earned by such properties. However, Sebi has identified various issues with the present structure including a lack of regulatory oversight, lack of liquidity and redemption avenues, no investor grievance redressal mechanisms, and opacity in valuations of commercial properties to name a few. Recognizing these constraints, Sebi finds it imperative to bring the FOPs under its regulatory purview, and has proposed to bring these under the real estate investment trust (REIT) structure, and has termed these as micro, small, and medium (MSM) REITs.

In the consultation paper, Sebi has proposed various norms in relation to registration requirements including qualification and net worth requirements; fund structure; fund size; valuation and disclosure requirements, among others. This article discusses a few proposals that may bring out the merits, and points for reconsideration from the consultation paper. The first change that will be observed by the industry would be the structure of these offerings. FOPs would be required to migrate from the present SPV structure to adopt a traditional trust/fund structure prescribed by Sebi across multiple vehicles of pooled investments such as mutual funds, and alternative investment funds. In this structure, the sponsor would be required to establish a trust that would hold the SPV, and the SPV would invest in the commercial real estate properties. The sponsor shall appoint a trustee to govern such trust, and the trust shall appoint an investment manager to manage the investments, as well as the operational aspects of the commercial properties. The trust shall issue units of a MSM REIT through public offer, and such units shall be listed on the stock exchanges.

The fund size presently prescribed for REITs is minimum Rs 500 crore (5 billion), with a minimum public offer requirement of `250 crore. In recognition of the growing retail and non-institutional interest in FOPs, Sebi has proposed to keep the minimum fund size for MSM REITs as Rs 25 crore, with a maximum size of `499 crore. This lower size should attract higher interest from the industry, and incentivise market players to issue multiple schemes. Further, by mandating the listing of the units of such schemes on the stock exchanges, the investors would be provided with liquidity, and would not have to rely on the FOPs to dissolve their investments, if required. The proposed valuation and disclosure norms also provide for higher transparency in relation to the funds’ investments, and grievance redressal under the SCORES platform provides investors with a heightened sense of security when considering such investments. In relation to the pay-out obligations of such MSM REITs, the proposed norms mandate that not less than 95% of net distributable cash flows of the SPV shall be distributed to the scheme of MSM REIT, and 100% of net distributable cash flows of the MSM REIT shall be distributed to the scheme-wise unit holders.

While the abovementioned proposal will make MSM REITs a lucrative product for issuers as well as investors, Sebi may reconsider the following proposals to make FOPs more attractive and accessible. First, the proposed minimum investment in MSM REITs is Rs 10 lakh (1 million), and further investments may be made in multiples of this. In comparison, the REIT regulations presently require a minimum investment of `10,000-15,000. Recognizing that MSM REITs may garner interest from retail and non-institutional investors, Sebi is right in keeping a higher threshold for the riskier product as compared to a regular REIT.

Second, Sebi has prescribed minimum net worth requirements of Rs 20 crore for the sponsor, and 10 crore rupees for the investment manager, and has specified that Rs 10 crore shall be in the form of unencumbered liquid assets such as cash, money market instruments, government securities, treasury bills, and repo on government securities. These high net worth requirements may act as entry barriers for new fintech players seeking to offer such products either as sponsors, or as investment managers, but may be necessary given the investor protection which may be required for the product.

Third, the proposed norms require the sponsor to hold at least 15% of the post-issue units of a MSM REIT for a period of three years post the initial offer. This is an additional burden for the sponsors. This norm may be aligned with the present norms requiring the sponsor of a REIT to hold only 5% of the post-issue units. Most of the current offerings have no skin in the game and a gradated approach may be better as a 5% investment in the first few years can be increased to 10% or 15% after some period of time.

Sebi may also consider granting a longer transition period for existing FOPs to the proposed structure. Given the complexities of the proposed structure containing multiple layers, and appointment of various entities, and the listing requirements, it may not be feasible for existing FOPs to migrate to the proposed structure within a six month timeline, and Sebi may provide an extended timeline in consultation with the market players.

The proposed framework to govern FOPs by migrating to the MSM REIT structure offers a viable solution to bring these entities within the regulatory framework, without having to create a new class of intermediaries. It provides requisite legitimacy to such platforms by bringing them under the regulatory mantle of Sebi, and comfort to the investors while investing in such products. While most of the proposals presented through the consultation paper accommodate the FOP structure that has managed to attract interest from retail and non-institutional investors and strengthen the governance mechanisms of such offering, certain requirements may be reconsidered to keep the entry barrier lower, and make Such products are more attractive to the issuers as well as investors.

(The author is managing partner, Finsec Law Advisors. Co-authored by Mihir Deshmukh, associate, Finsec Law Advisors.)

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